Healthcare Stocks Are Trading at Their Biggest Discount in 30 Years. Why a Turnaround May Have Already Started.

UnitedHealthcare Group is the worst-performing stock in the Dow this year. (Dreamstime)

Healthcare stocks have been in a funk. For investors worried about elevated market valuations, they may be just what the doctor ordered.

The healthcare sector is enduring one of its worst patches on record, thanks to a slew of problems that include managed care costs and stiffening competition among blockbuster weight-loss drugs. In the past 12 months, the Health Care Select Sector SPDR , an index fund that tracks the industry, has dropped 11%, while the S&P 500 has gained 14%.

Healthcare stocks have fared a bit better in recent weeks—and have moved 3.7% higher over the past four weeks compared with 1.8% for the broader market. UnitedHealth Group , the worst-performing stock in the Dow this year, got a recent vote of confidence from Warren Buffett’s Berkshire Hathaway, which bought 5 million shares this summer. Shares have rallied 9.6% since the news was disclosed Aug. 15.

Investors have been worrying recently about the hot but hypercompetitive market for GLP-1 weight loss drugs. Shares of Eli Lilly took a 14% hit earlier this month, when the company revealed disappointing test results for a weight-loss pill investors hoped would replace the current injections. But shares have regained some ground this week, rallying about 4%. On Tuesday, a new potential GLP-1 competitor from Viking Therapeutics revealed its own trial problems.

It’s easy for good news to move the healthcare needle—in part because the sector is historically undervalued relative to the rest of the market.

Healthcare stocks are trading at 16.6 times forward earnings, below their historical average of 17.4 times, according to a recent note from Evercore ISI’s strategy team led by Julian Emanuel. Meanwhile, the S&P 500 as a whole is trading at 23.3 times—far above its historical average of 16.7 times. It adds up to the biggest relative discount healthcare stocks have enjoyed in 30 years, according to the firm.

What’s more, the Evercore team thinks the past month’s rally could continue. Healthcare stocks are not only cheap: they tend to do well during periods of slow gross domestic product growth and relatively high inflation, much like today. “Health care historically outperforms when GDP is 1.5% or lower while inflation is 3% or higher, which [the] combination of recent statistics indicates is likely,” the analysts wrote.

Healthcare stocks also stand to benefit if investors finally grow wary of ever more richly valued tech shares, according to a note Wednesday from DataTrek.

Co-founder Nicholas Colas noted that below the headline numbers, the sector’s performance is actually mixed, with stocks like UnitedHealth, Eli Lilly, and Merck posting year to date losses, but shares of other names, such as Johnson & Jonhson and AbbVie, are beating the market.

“There’s nothing ‘wrong’ with Health Care as a group. Rather, several individual names are simply doing poorly,” he wrote. The mixed performance, he said, makes it hard to identify a catalyst that could catapult the entire sector forward.

But with tech stocks looking increasingly pricey—they currently trade at 28.5 times forward earnings—investors may be looking around for a cheaper alternative.

“Healthcare tends to work when tech takes a hit, since both are nominally growth sectors, so readers who are concerned that tech is overextended may want to look at this group right now,” he said.

Write to Ian Salisbury at ian.salisbury@barrons.com